Activity Based Costing benefits businesses that are more complex in nature. In this case, Greetings. INC has added a new product line, Wall Decor, which permits them to grow without expanding their physical stores; however, they have significantly raised their overhead costs by multiplying their cost drivers. Not to mention the fact that they have incorporated a largely automated system into their product line, which we know calls for an ABC system.
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The main reason to move to ABC though, would be because it will allow management to make better decisions and move away from the “cash machine” and “lemonade stand” metaphor simply because overhead costs will be allocated in such a way that corresponds to either framed or unframed prints instead of considering the same overhead for both products.
By doing so managers will be able to price the prints competitively while still maintaining a profitable margin. An activity-based costing system may be appropriate for Wall Decor, when overhead allocation based job-order costing provides product cost distortion. Wall Decor should change its costing system for selling its high volume produced products whereas low-volume produced products have good profit.
Overhead allocation based job-order costing had been resulted the price distortion for specially unframed prints, not considering their job capacities. But in reality, when ABC system applied on overhead allocation for unframed prints, apparently it is seen that the price decreased. This happens, because unframed prints in working process consume less resource from identified activity pools of ABC system compared to framed prints.
Among the activity pools, the first is inventory selection and management activity that unframed prints get less share of overhead cost for this activity due to the counts of their components per print items. The second is web-site optimization activity that unframed prints again get less share of overhead cost for this activity due to less requirement of IT professional labor. The last is the framing and matting activity that only apples to framed prints, not unframed.
Because production of unframed prints does not require frame and matting equipment, space and other overhead costs related to framing and
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matting. The potential implication of applying ABC system in the company is that there will not be product cost distortion and will provide the more accurate and that resulted in better product pricing and more accurate evaluation of the relative profitability of the products. 5. Website Optimization proved to be very time consuming because it required an IT engineer to upload each print with each possible frame combination.
In order to show the difference of amount of time spent on web optimization by IT professionals between on unframed and framed prints, total cost of web optimization activity had been split between unframed and framed categories. Time of IT professionals was used to subdivide the cost by resource consumption between unframed prints and framed prints. After this allocation identified, it is easy to see that how much of IT resources are being consumed by framed and matted prints, followed by a more accurate and efficient pricing strategy.
Whenever a company applies activity-based costing it is because they have more complex operations, which includes more product variables. In this case we noticed that, although they had already divided the products into two cost drivers (unframed and framed), we could achieve higher price accuracy if we considered that there was a significant overhead cost disparity between different framed products. To address this, the framed prints cost driver was divided into steel-framed prints and wood- framed prints with matting.
The best option is to simplify the categories, in result, reducing the cost of ABC system. 7. When allocating fixed overhead costs using operating capacity, it is easy to determine how much each product costs at capacity and be able to manage the costs based fixed overhead costs. But when allocating fixed overhead costs using the expected unit sold, then overhead allocation will be distorted. By allocating overhead costs based on capacity this distortion can be avoid. That is why, using the operating capacity for allocating fixed overhead costs can result accurate cost.See More on Costs